Hello Professor. Why don't we use the tax when calculating the new rE? I understand why using it when calculating the WACC but would've imagined the same for rE. Thanks
\(r_D\) is the required return to debtholders. Once we have taxes, the cost is lower \((1-t)r_D\)
Consequently, the cost of financing overall gets lower (WACC)
Since we only have corporate tax, the amount equityholders require is the amount I must pay, so there is no benefit in this case of taxes.
Your intuition is kind of correct, though. We could correct everything and obtain the after-tax equity cost:
\(r_E = r_{WACC} + \dfrac{D}{E}(r_{WACC}-r_D(1-t) )\)
You should obtain exactly the same value as with the method in the Excel sheet
Consequently, the cost of financing overall gets lower (WACC)
Since we only have corporate tax, the amount equityholders require is the amount I must pay, so there is no benefit in this case of taxes.
Your intuition is kind of correct, though. We could correct everything and obtain the after-tax equity cost:
\(r_E = r_{WACC} + \dfrac{D}{E}(r_{WACC}-r_D(1-t) )\)
You should obtain exactly the same value as with the method in the Excel sheet